State and Local Public Policy from the Mercatus Center

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Trapped by Government Privilege

The right to operate two New York City taxi cabs has just been sold for $1 million apiece.

In order to operate a cab in New York City, the government requires drivers to affix little aluminum plates called medallions to the hoods of their cars. According to the article:

There are 13,237 medallions in the city; new ones, when issued, are sold at auction. But the medallion pool is rarely expanded, creating a scarcity that helps keep values high.

By restricting the supply of legal cabs, the policy effectively raises the price of a ride. It also leads to what Matt Yglesias calls “endemic taxi shortages in the outer boroughs.” As Felix Salmon notes, though, even if the city issued more medallions, fares wouldn’t go down since another city policy regulates those.

(Image courtesy of Stuart Miles / FreeDigitalPhotos.net)

Salmon then asserts that “utter chaos” would result if both policies were removed because riders would have to haggle with cabbies every time they rode. This seems like a rather absurd concern. Do you haggle with the local gas station operator every time you fill up? Is there utter chaos because magazine prices at newsstands are set by the market and not by regulation? Matt Yglesias adeptly dispatches with Samon’s concerns, writing:

In fact in Stockholm they’ve done what Salmon says can’t be done, and taxis are allowed to charge whatever price they like. The main solution to the problem he identifies is that most cabs are affiliated with one of a few large taxi companies that have posted fare schedules.

Let’s dig a little deeper into the economics of this. Both the price control and the medallion requirement seem to benefit cab companies at the expense of riders by raising prices above what the market would naturally bear. But as Gordon Tullock pointed out in a classic 1975 article called “The Transitional Gains Trap,” the cab operators really aren’t better off in the long run:

[T]he capital value of the monopoly profit has been fully taken into account in the industry. New entrants enter only by purchasing the medallion, with the result that they get only normal profits.

In other words, those who want to charge monopoly prices must pay dearly for the privilege of doing so. And today the going rate is about $1,000,000. This is essentially the same story with any type of rent-seeking activity. If you want the government to give you a competitive advantage against your competitors, you can ask for a subsidy or a tax on your competitors, but expect to spend a lot of money lobbying for these favors. In fact, as Tullock argues, you should expect to spend so much money that in the end, you will only make a normal profit! Indeed, that’s why protected industries like autos, steel, agriculture, and green energy do not systematically make above-normal profits. (In pointing this out, David Friedman has opined that “the government can’t even give anything away.”)

But the story gets worse. Now let’s imagine that the government tries to do the efficient thing. Let’s imagine it listens to Matt Yglesias or me and deregulates the taxi cab industry. Well you can bet that the poor person who just paid $1,000,000 for the right to charge a monopoly fare is going to be more than a little resistant to any policy change which would make his fares go to the competitive level. In fact, the political resistance would be so great that Tullock called the entire policy a “trap” concluding:

The moral of this, on the whole, depressing tale is that we should try to avoid getting into this kind of trap in the future.

Think of this the next time you hear about a proposal that is likely to benefit one group at the expense of others.